The options trader is looking for low volatility in the markets and the underlying security. To do this, he has to do economic and fundamental analysis. With fundamental analysis, the options trader may come to a conclusion that the price of the underlying security has very little upside and downside. Perhaps, the price of the underlying security is already fairly valued. The options trader must avoid events that cause spike in volatility levels. With regards to technical analysis, the trader is looking out for patterns of stagnation or chart patterns with very tight and narrow ranges. Suggested chart patterns to look out for are:

The trader who executes a short put synthetic straddle is anticipating little to no volatility in the price of the underlying security. When that happens, there is a higher probability of the trade turning a profit. The payoff curve of a short put synthetic straddle is an inverted “V” shaped one. As such, the maximum profit is achieved at only 1 price point, the exercise or strike price of the puts involved.

A loss occurs when the price of the underlying security is trading above or below the breakeven points. The loss is unlimited due to the way the short put synthetic straddle is constructed – Short stock and short puts.

Profit is limited for a short put synthetic straddle. The maximum profit occurs when the price of the underlying security is equal to the exercise or strike price of the put options on expiration date.

Since the risk of the short put synthetic straddle is unlimited, consider putting in place stop losses on the short put synthetic straddle. After this has been done, the options trader is able to calculate the risk and reward ratio, that is, the maximum potential reward for every dollar of risk taken. Do take note that for a short put synthetic straddle constructed with ATM puts, the maximum reward or profit occurs at only 1 price point.

After the trade has been exited, the trade’s performance should be recorded in a diary or a journal. The trader should conduct some personal reflection on the trade and compare his success or failure with trades of a similar nature. The trader should also find ways to improve on his personal trading algorithm.

Example Of A Short Put Synthetic Straddle

RRR Corp is trading at a price of $60. A trader foresees little volatility in the stock and decides to execute a short put synthetic straddle by shorting 100 shares at a price of $60 and writing 2 Dec 60 puts at a price of $1.50 each.

As a result, the net credit is:

$1.50 x 2 = $3

If the price of RRR Corp trades at $60 on expiration of the options:

Beginning value

Ending value

Profit(+) or Loss(-)

Short 100 shares

$60

$60

$0

Short 2 Dec 60 puts

$1.50

$0

+$3

Overall profit per share

+$3

The total profit in this instance is:

$3 x 100 = $300

The net credit is thus the maximum profit as well.

If there is a significant price swing to $100 on expiration:

Beginning value

Ending value

Profit(+) or Loss(-)

Short 100 shares

$60

$100

-$40

Short 2 Dec 60 puts

$1.50

$0

+$3

Overall loss per share

-$37

The total loss in this instance is:

$37 x 100 = $3700

If the price of RRR Corp trades at $20 on expiration:

Beginning value

Ending value

Profit(+) or Loss(-)

Short 100 shares

$60

$20

+$40

Short 2 Dec 60 puts

$1.50

$40

-$77

Overall loss per share

-$37

In this case, the total loss is:

$37 x 100 = $3700

As you can see, with large price swings in either direction, a huge loss will result.

Short Straddle, Short Call Straddle & Short Call Synthetic Straddle

The strategies above are comparable strategies in that they have a similar payoff profile.